Getting Straight on Small Business Job Creation: Firms vs. Establishments

July 18th, 2012 at 9:59 pm

I like small businesses. I like medium size and large ones too. I like ‘em all, and while size matters — small firms face different, and often more challenging, hurdles than large ones — I fear we risk systemic distortions if our policies are too dependent on firm size.

But aren’t small firms the job creators? As I’ve stressed before, not especially, despite the fact that you hear this mantra hourly from policymakers of both parties. Some new data on private sector employment by firm size from the Bureau of Labor Statistics is especially revealing.

[This is from a new, experimental data series from the BLS, i.e., not yet part of their normal data production — for now, the data only go through March of 2011.]

The first figure, from the BLS link above, just shows the time series in jobs by firm size, with the three size classes in the new series, 1-49, 50-499, and 500+, so small, medium, and large. Over the full period the average shares for each don’t change much: 29% of jobs are at small firms, 27%, medium, and 45% large. There’s been a small shift — a few percentage points — from medium to large since 1990, but the small shares been roughly constant at 28-29%.

So, the question is, do any of these size classes contribute disproportionately to job growth? In fact, they do, and the winner is…not small firms. Whether is business cycle expansions or the full run of these data, large firms — 500+ employees — contribute disproportionately to job growth. The small firms — less than 50 workers — in fact, contribute proportionately less than their share.

That may surprise you if you’re used to hearing the opposite, which you hear a lot. There’s a reason for the different findings: establishments versus firms.

The BLS data break employment down by firm size, while other sources, like the ADP jobs data — one of the sources of the big-job-creator claims for small biz — do so by establishment size. That’s not wrong, per se, but when we think about small businesses, most of us are thinking firms, not establishments.

An establishment is defined as an economic unit that produces goods or services, usually at a single physical location, and engaged in one or predominantly one activity. A firm is a legal business, either corporate or otherwise, and may consist of one establishment, a few establishments, or even a very large number of establishments. [my bold]

In other words, establishments can be units of large firms, but a firm under 50 is truly a stand-alone small business. A GAP outlet with 40 employees is counted in the 1-49 size class in the ADP data—it’s a small establishment. But since GAP is a very large firm, in the BLS data, that 40 person outlet is assigned to the 500+ group.

To be clear, I’m not saying ADP and other surveys that base size of establishment as opposed to firm size are wrong. But I don’t think the GAP, or Apple, or CVS, or UPS are “small businesses” even though they all have some small establishments that get counted that way in ADP-like surveys (ADP, btw, is very forthright about this point—see note at end).

So what kind of difference does it make? Huge.

The figure below shows job growth, in thousands of jobs, by firm size (BLS data) and establishment size (ADP) over the 2000s expansion (Nov01-Dec07). They tell a totally different story. While the totals are about identical at around six million, the establishment data would lead you to believe that 80% of the job growth came from small businesses (1-49), but when you actually look at small firms — so you’re excluding the smaller outlets of the large firms — you see they punched at just below their weight: they created 26% of the jobs; they account for 28% of total employment over this period.

Sources: BLS, ADP

Large establishments were actually a negative over this period, according to the ADP, but large firms accounted for the greatest share of job growth in the 2000s expansion.

If you do the same exercise for the most recent period of job growth, beginning in February 2010 through March 2011 (which is when these BLS data end for now), you get a similar result. Small establishments created 44% of the jobs over these months; large ones only 5%. But small firms created only 17% of the jobs; large firms, 56%.

This morning I got coffee from Saint Elmo’s Coffee House, a great small firm in my ‘hood. I then went next door to a UPS outlet, where one employee was at work. But that doesn’t make UPS a “small business.” More germane, when small businesses are asking for special policy treatment, let’s be clear that it’s the small firms we typically think we’re talking about here, not the small establishments. And those firms are not disproportionate job creators.

The next figure shows what I mean. For the full period of the BLS data, 1990-2011, it plots employment shares by firm size — the averages over the period — against the shares of job gains. As you can see, small firms (1-49) created a smaller share of job than their employment weight and large firms (500+) were the disproportionate job creators.

Source: BLS

To reiterate, as I’ve always stressed in this discussion, small firms face barriers large firms don’t — access to debt and equity markets, limited cash reserves, export barriers, and less of a cushion in hard times. Public policy should help them overcome these barriers. In fact, given that the NFIB — the hyper-conservative lobbying group — now appears to be more about the Koch brothers’ anti-tax, anti-regulatory agenda than actually helping small firms, groups like the Main Street Alliance are ever more important.

Neither does it make sense to get all wound up about job creation by firm size. It’s far less important than the small-biz centric discussion suggests. Small startups that survive and grow have been found to be key contributors to job growth (see second link above), but beyond that, many small firms grow, many large ones shrink (regression to the mean) and at the end of the day, we want to see robust creation of good jobs, regardless of size class.

So the next time someone’s crowing about how the lion’s share of the job growth is coming from small businesses, ask them if they’re talking firms or establishments. If it’s “firms” they’re wrong. It it’s establishments, they’re not really talking small businesses.

Note: The ADP is explicit about this firm/establishment difference—at the bottom of their spreadsheet they write:

“All size data included in the ADP National Employment Report is based on size of payroll. In some cases, small and medium-size payrolls belong to businesses employing more workers than indicated by the size grouping.”

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14 comments in reply to "Getting Straight on Small Business Job Creation: Firms vs. Establishments"

This is off the topic at hand but maybe, just maybe you will read it. Every agrees that Willard Romney made a lot of money during his years at Bain Capital. It dawned on me this evening that he did so under the tax structure of the Reagan, George H W Bush and Bill Clinton years. Those tax rates, which were sufficient to lead to balanced federal budgets, were not so burdensome as to prevent Mr. Romney from making a lot of money. So why now must he insist that we need to reduce tax rates or keep them low, in order to create jobs?

Here is an idea. Return tax rates to the Clinton years. Allow a suitable tax credit for every new job created, whether by a small business or a large one.

This does fit my experience better than the “small firms create growth” mantra. Chains and franchises are more and more common to my eye.

This may have something to do with Michael Spence’s tradeable and non tradeable sectors.

UPS and firms like them have small establishments everywhere there are people. That would put them in the non-tradeable sector by Spence’s definition. However, the well-paid and interesting jobs in those firms are in headquarters. This makes the chains/franchises a bit more like the tradeable sector (by Spence’s definition, the tradeable sector is concentrated in one place, and can service a large geographic area from there.)

There may be a category between tradeable and non-tradeable sectors, the franchise/chain sector, where establishments without much decision power and with badly paid jobs are spread over the country, while the good jobs are concentrated into headquarters.

Headquarters is located where the management wants to live and where the company can recruit well-educated people from a large job market. That is not necessarily in the United States, of course.

I wonder if the ongoing chain/franchising trend isn’t making the good jobs even better (a manager at chain headquarters will have much more impact and pay than the proprietor of a local shop), while removing the good middle class jobs from local communities (your local UPS employee is probably not paid much more than the minimum wage and has little control over her work, while the proprietor of a local shop can earn more than the minimum wage and certainly has more control over her work).

This trend could be part of the ongoing polarization of the USA society.

I have never seen this distinction made before. The fact that the vast bulk of the post-crash jobs have been created by large firms has further explanatory power. It explains why those jobs are, mostly, below-living-wage service jobs, for one. It is much easier to pay unseen, anonymous workers starvation wages. It is much more difficult to pay workers starvation wages when they live in your town and work elbow to elbow with you as the legitimate small business, erm firm, owner.

It’s also much easier to create draconian rules, offer no benefits, and generally treat human beings as if they are cogs in your own money-making machine. To the extent we are experiencing a recovery, and to the extent that recovery involves hiring, it seems to involve hiring into pretty terrible jobs. The firm/establishment distinction, and the predominance of big firms in hiring, helps to explain why.

We as a society have established a floor below which we do not allow jobs to go. Most newly-hired workers after this recession are lying face down on that floor. That is the most profitable state of affairs for their corporate masters, after all.

Some small businesses pay good wages and provide good benefits. There are a large number, however, that pay lousy wages with no benefits at all. I’ve never found that small employers were at all embarrassed to pay barely-above-the-minimum wages and zero benefits. My husband worked for a small business for about four months and, in addition to the lousy wages, we got to attend dinners with the family that owned the business. It was nearly 30 years ago, and I still remember the horror.

I speak regularly speak to workers who are not allowed to leave their work stations for any reason outside legally required break periods. Yes, that includes bathroom breaks. More than one of them has told me they regularly wet themselves rather than risk losing their jobs (diabetics and pregnant women are particularly vulnerable). This kind of unconscionable treatment, along with all the accompanying shortcomings in wages and benefits you might expect, is not something you see in small firms. It’s unique to the dehumanhizing world of the huge employer.

I grant you that not all small firms are run by saints, nor do they all treat workers well. That said, I’ll take a small employer over a huge one any day.

Negative net job creation among small firms at least in part reflects turnover of the firms themselves…especially in today’s economy. For many small businesses, the life cycle of the business is short and the equity cost to the owner is high. Creating a business and funding its likely failure amounts to a very busy early retirement…all of ones savings and home equity may be gone with nothing to show for it.

In a tough employment market, entrepreneurship may seem attractive. However, the risk exposes the individuals and the system to worsening conditions in the long run. The investment in the business is lost to the investor. There is an opportunity cost to the savings and investments portion of GDP. And there is an individual with lower demand and greater need for safety nets in old age.

First, a question: What about franchise owners and their employees. Many are individually owned and operated, and they hire their own employees. I would call them small businesses if they have fewer than 50 employees, even though they are part of a chain like McDonald’s. Is that where they are in the data that is shown?

Second, it would be interesting to see what the data show on the number of small businesses owned by individuals who make less than $250,000 per year versus the number of small businesses with owners who make more than that amount, and their respective job creation amounts.

The questions would be: do owners of small businesses where the owner makes less than $250,000 per year (which would be unaffected by Obama’s proposal to only let the tax rates revert to pre-Bush tax rates on those who make more than that amount)provide the most job creation in the small business category?

Also, what is the evidence that owners who make more than $250,000/yr would not create more jobs even under Clinton-era tax rates? It is possible that such wealthy owners would continue to invest in their businesses by such actions as hiring more employees to increase business revenue and their wealth, even if they were taxed at a higher rate.

That is one thing I have never been able to understand..why would a small business making over $250,000 a year not invest in expanding their business just because the additional income will be taxed slightly higher?? Short of a 100% marginal tax rate, wouldnt the business always be better off expanding, even if the additional earnings are taxed slightly higher?

Re franchises, it’s not a simple question, because it depends on which EIN is submitted to the IRS. Here’s the BLS on this point:

“For these data, firms are identified by the unique Employer Identification Number (EIN) issued by the IRS. Multiple establishments that share the same EIN are counted as a single firm, and employment from each establishment is aggregated to determine employment for the firm as a whole.”

I believe this is not consistent over franchises–some have their own EINs and others don’t.

According to your graph, if you considered small businesses to be anyone who employs less than 500 people, those “small businesses” would account for more than the large businesses. By splitting this group into two, you can tell the opposite story.

If you were to split the large businesses into “large” and “huge” you’d get yet another story. How to mislead with graphs…

There’s another economic advantage that small businesses have: they are the path to building wealth for individual entrepreneurs in a way that a large business isn’t.

You’ve listed a number of ways they are disadvantaged. What you’ve left out is “taxcode”. My suspicion is that you’d find that small businesses pay higher rates than the large ones– many of which we’ve recently been informed by the media pay little or nothing at tax time.

The large firms do so by targeted loopholes. Small businesses can’t pay the lobbyists to buy the loopholes.

An advantage to streamlining the taxcode, removing the loopholes, and lowering the overall rate (even if it isn’t revenue neutral– even if, as you prefer, that leads to revenue increase) is to reduce the advantage that the taxcode provides large businesses over small ones.

How many people/families who make over 200K/250K a year (i.e. those that would be impacted by President Obama’s proposed tax increases) own a “small business” vs are just making that amount of income because either their wages are very high or because of capital gains?